Under new legislation enacted late last year, the 2011 and
2012 estate, gift and GST tax exemptions were increased to $5 million — the
highest exemptions in history. With just 15 months left until the
exemptions are scheduled to revert back to $1 million as a part of the expiration
of the extended Bush tax cuts (absent further legislation), now is the time
to act if you have not yet already used your full gift and GST exemptions
and are interested in doing so.

The gift and estate tax exemptions are unified under current
law. This means that if you use your $5 million exemption today, your
exemption remaining at your death will be $0. That said, there are several
benefits to using your gift and GST tax exemptions to make a large lifetime
gift now, rather than waiting until death:

·Lifetime gifts are especially useful in saving state estate taxes,
particularly if you live in a jurisdiction that imposes an estate tax but
not a gift tax (such as Massachusetts or New York).

However, there are also some drawbacks:

·You may not want to gift low-basis property (donees
receiving gifted property take the donor’s “carryover basis,” whereas,
under current law, the basis of an asset received at death is “stepped up”
to the asset’s fair market value);

·Gifted asset values may decrease, resulting in a waste of a portion
of your exemption; and, most importantly,

·The risk that you may need the money at some point in the future.

When making a large gift, you should seriously consider the
use of a trust. Making a gift in trust allows you to separate the timing of
the gift (which is often driven by tax motivations) from the timing of the
distributions (driven by family and financial factors). In addition, using
a trust can provide income and GST tax benefits, and you can structure the
trust so that it gives your beneficiaries significant (although not total)
control.

Sell/Loan
Assets to Trusts While Interest Rates Are Low

If giving away a significant amount of wealth makes you
uneasy, but you still wish to take advantage of current gifting
opportunities, you may consider selling or loaning property to a
trust for the benefit of your family members. As long as the transferred
asset appreciates more than the interest rate you charge, you will have
removed the future appreciation from your taxable estate while maintaining
the current value of the asset for yourself. For this reason, this approach
is often called an “estate freeze” technique.

These techniques are especially attractive given today’s
interest rates. The IRS just announced the following minimum rates for
October: 0.16% for short term loans of less than 3 years; 1.19% for
mid-term loans between 3 and 9 years; and 2.95% for loan terms exceeding 9
years. These are the lowest rates in history.

Under this approach, you would sell assets to a trust (or
lend money to the trust) and take back a note at a minimal interest rate.
The trust could be structured in such a way that a sale of assets does not
trigger any income taxes as a result of the sale. At the end of the loan
term, any appreciation in excess of the interest rate remains in the trust
for the benefit of your family members.

GRAT Interest
Rate Lowest in History

Like the sale technique discussed above, the GRAT (Grantor
Retained Annuity Trust) is another gift tax-efficient mechanism to shift
future wealth to your heirs. Under this strategy, you would create a trust
under which you would retain the right to receive annual annuity payments
for a fixed period (usually two to five years). After the annuity payment
period expires, your interest in the trust would terminate, and your family
members (or a trust for their benefit) would receive the balance free of
gift tax.

The October interest rate used for GRATs dropped to an
all-time low of 1.4%, making it easier than ever before to transfer wealth
through the use of this mechanism. For example, if you transfer a $1
million asset to a three-year GRAT, and that asset appreciates 15% annually
over the three year period, your heirs will receive approximately $350,000,
free of any gift tax, and you will have received approximately $1,030,000
back in distributions.

There are several downsides to a GRAT, including the
inability to allocate your GST exemption to the gift (meaning that
distributions to your grandchildren from the resulting trust could incur a
tax), and that you must survive the term in order to realize any tax
benefits. In addition, several bills severely limiting the effectiveness of
GRATs have been proposed in Congress.

Under the right circumstances, however, the GRAT can be an
ideal way to transfer significant wealth to your heirs with very little
downside risk.

Annual
Exclusion Gifts

Even if you do no other planning this year, please be sure to
use your 2011 annual exclusions. Under current law, you may give $13,000
per person, or $26,000 if you are married, to or for the benefit of any
number of beneficiaries. Annual exclusion gifts do not reduce your gift and
estate tax exemptions, and can be made directly to your beneficiaries, or
indirectly through trusts or college savings plans. In addition, you may
pay tuition or medical expenses on behalf of a beneficiary without any gift
tax consequence, as long as the payments are made directly to the school or
medical provider.

Time to Act

The confluence of increased tax exemptions, low asset values
and low interest rates make this the ideal time to consider gifting
strategies. The increased estate, gift and GST tax exemptions are scheduled
to sunset at the end of 2012 and legislation may soon limit the
effectiveness of GRATs. With the uncertainty in Washington, the future of
the tax system is anyone’s guess. What we do know for certain, however, is
that these opportunities are available now.

Please feel free to call us to discuss how these and other
techniques may help you and your family achieve your estate planning
objectives.

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